When Future is Uncertain, Households Work and Save More

Uncertainty enters daily life in great many ways, yet its repercussions on people's livelihood and on the economy in general are far from straightforward. Inspired by the question marks raised about the effects of uncertainty, Francesco Giavazzi (IGIER, Bocconi) and Michael McMahon (University of Warwick) in their Policy Uncertainty and Household Savings (forthcoming in the Review of Economics and Statistics, doi:10.1162/REST_a_00158) investigate how households respond to an increase in policy uncertainty. Using German micro-data and a quasi-natural experiment, authors show that household saving increases significantly as a response to the heightened levels of political uncertainty in the run-up to the 1998 German general election. In addition, they provide evidence on labor supply response by workers who can use the part-time employment margin. Authors conclude that increased levels of uncertainty, brought by "wars of attrition" in the form of political disagreement that might give way to reform delays or revoking previous reforms, have economic consequences, and, in fact, could slow down the economy.

Authors use the number of people who respond to a German consumer survey that they are "uncertain about the general economic situation in their country over the next 12 months" as a measure of uncertainty in the run-up to the German general election held in September 1998. Authors view the increase in uncertainty as a consequence of the tight race in the election and the differential policies it could potentially bring about, which sets up a suitable ground for study in the form of a quasi-natural experiment.

Once established a working measure of uncertainty the authors look into the ways households react adjusting their saving and labor supply decisions. They treat civil servants as the control group in a diff-in-diff estimator for they have jobs for life and a separate protected pension system which render them unharmed by the possible changes elections might project on unemployment and pension policies.

Authors provide evidence on significant household saving increases as a response to the surge in uncertainty about the future path of income. A household that formerly held savings constant at 8.9% of disposable income as of 1998 boosts his saving rate up to 15.9% by year 2000.

Moreover, authors inspect household responses in the labor market and scrutinize primary and secondary job decisions by all working-age household members. They show that households react by adjusting their labor supply on the flexible margin, i.e. part-time employment. A head of household working only part-time increases her hours of work from 10 hours a week up to 19 hours a week.

To conclude, this paper sheds light on three different main issues. First, it offers a direct way to measure how households react to an exogenous increase in uncertainty as a result of a quasi-natural experiment, which could be interpreted as a measure of precautionary savings. Second, the evidence on labor supply adjustment shows us how households use the flexibility of part-time employment. Lastly, no matter what the source of uncertainty is, "wars of attrition" between political parties have economic adverse effects as the increased political uncertainty might lead people to consume less, and hence, might slow the economy down.